QMCO - NASDAQ

Good afternoon and thank you for joining today's conference call to discuss Quantum's Second Quarter Fiscal Year 2023 Financial Results. I'm Brian Cabrera, Quantum's Chief Administrative Officer. Joining me today are Jamie Lerner, our Chairman and CEO; and Mike Dodson, our CFO. This afternoon, we issued a press release which you can access under the Investor Relations section of our website at www.quantum.com. We are using a slide presentation in conjunction with today's call, also accessible under the same section of our website. During today's call, our comments may include forward-looking statements. All statements other than statements of historical facts should be viewed as forward-looking. These statements include any projections of revenue, margins, expenses, adjusted EBITDA, adjusted net income, cash flows, or other financial items. These statements may also concern the expected development, performance and market share or competitive performance of our products or services. All forward-looking statements are based on information available to Quantum as of today's date. We advise caution in relying on these statements as they involve known and unknown risks and uncertainties we refer to as risk factors. Risk factors may cause our actual results to differ materially from those implied by the forward-looking statements, including unexpected changes in our business. We include detailed information about these and additional risk factors under the sections labeled the Risk Factors in our quarterly report on Form 10-Q and annual report on Form 10-K which we file with the Securities and Exchange Commission. We do not intend to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise, except of course, as we are required by applicable law. Please note that our press release and the management statements we make during today's call will include certain financial information in GAAP and non-GAAP measures. We include definitions and reconciliations of GAAP to non-GAAP items in our press release. If you are unable to listen to the entire call at this time, we will make a recording available for at least 90 days in the Investor Relations section of our website. Now, I would like to turn the call to our Chairman and CEO, Jamie Lerner. Jamie?

Thank you, Brian and thank you all for joining us today. Earlier this afternoon, we announced results for our second quarter of fiscal 2023, with revenue just above the high end of guidance, driven by a record quarter in our hyperscale business as well as sequential improvement in our EBITDA results. The supply chain situation continues to improve, both in terms of tape drive supply and overall availability of materials at more standard pricing and lead times. Our access to tape drives from our largest supplier has shown greater predictability and consistency and we are expecting this incremental improvement in supply to continue in the coming quarters. We are also spending less money on broker fees and expediting fees as a result of our previously implemented initiatives. During the quarter, we also executed additional cost containment measures that lowered our operating expenses to our target quarterly run rate of $35 million which will support driving increased EBITDA as we continue to grow the top line. In addition to our strong revenue, bookings doubled sequentially and contributed to record backlog of $96 million at quarter end. This record backlog was not driven by supply constraints but rather large hyperscale orders for future quarters. Our in-quarter backlog has stabilized as our access to increased supply is allowing us to catch up on shippable backlog which Mike will discuss in more detail. Overall, our robust backlog gives us greater visibility and demonstrates the commitment from our large cloud partners to this business. Also in fiscal Q2, we delivered our sixth consecutive quarter of subscription revenue growth with subscription customers increasing to 554 from 455 last quarter. Delivering our data management solutions as a software subscription is an increasingly important part of how Quantum does business going forward. Our customers are asking for this type of purchasing model, yet they still value running our software on Quantum appliances in order to rely on a single vendor for support. We will continue to drive growth in ARR by driving increases in primary storage and non-hyperscale secondary storage software and systems and introducing new products based on subscription software licensing such as StorNext running on the AWS cloud which was launched in early September. While our near-term goal continues to be doubling of subscription software ARR to the $14 million to $15 million level, we now have a clearer picture of the time required to identify and close on these engagements. Therefore, our achievement of this initial milestone is increasingly likely to take place in early fiscal 2024. Although we have made progress on several of our stated initiatives, there is still more work to be done. During the first half of the year, we talked about expanding the earnings power of Quantum through a combination of pricing and discounting discipline, tighter management of the supply chain and operational expense reduction. As evidenced by my initial comments, we are beginning to see the evidence of these actions in our results. The other lever of utmost importance is expanding our gross margin which is tied very closely to our revenue mix. This applies not only to end market verticals but also from a geographic perspective. As many of you know, we get our best margins in North America as well as from our U.S. federal business. Both of these areas have been relatively weak over the past several quarters. Within the federal business, we've seen some large deals being pushed out and our non-hyperscaler business in the Americas has been impacted during the process of realignment of our sales team and appointment of new leadership. At the same time, our hyperscale business has been and will continue to be a strong growth driver for us, though it is at a relatively lower margin than the rest of our primary and secondary storage revenue. To further punctuate this point, our hyperscale business grew 32% sequentially and 68% year-over-year without a corresponding increase in our U.S. Federal or North America businesses. In order to improve our mix more favorably going forward, we began investing in broadening our sales and leadership teams in these areas over the last few quarters. I believe we are now back up to full strength and are well positioned to drive increased sales and more favorable revenue mix. In conjunction with these efforts, we are also focused on increasing our momentum in the enterprise market, particularly in the Americas. Industry analysts are projecting massive increases in the amount of cold data that must be stored and protected in the enterprise. As the market share leader in cold storage software and solutions and having worked alongside the world's leading hyperscale customers for several years, we have a tremendous opportunity to develop unstructured data solutions for Fortune 500 companies and help them address this massive data explosion taking place. With this greater emphasis on U.S. Federal in North America, we expect to see a more balanced revenue mix and associated margin improvement going forward. To give a broader sense of this opportunity, IDC estimates the worldwide scale-out file and object storage market to be over $30 billion by 2025, with emerging use cases like infrastructure for AI and business intelligence to be major growth drivers. Quantum offers a unique end-to-end portfolio to store, protect and enrich data across its entire life cycle and address critical needs in the enterprise like modernizing infrastructure to enable digital transformation, strengthening cybersecurity and using AI to unlock value in massive unstructured data lakes. We look forward to talking more about our go-forward product and business expansion strategy at our upcoming Analyst Day on November 17. Before turning the call over to Mike, I'd like to take this time to welcome the new additions to our Board of Directors. In August, Christopher Neumeyer joined our Board after serving as an observer since 2016. Having spent a decade at PIMCO and a big supporter of Quantum's business, he provides a wealth of experience in corporate finance as we focus on delivering improved financial performance and shareholder value. And we recently announced that in November, Don Jaworski and Hu Meyrath will be joining our Board of Directors. Both Don and Hu have a deep understanding of the market trends in our space and have experience in the broad enterprise IT market, having previously held Senior Leadership roles at companies like NetApp, Dell, Juniper Networks and Brocade. All of these new Board members will help guide our future strategy, particularly as we bring to market new products aimed at high-growth segments like software-defined storage, AI and machine learning and hybrid cloud. Now, I'd like to turn the call over to Mike to provide more details on the results. Then, we will take questions. Mike?

Thank you, Jamie. Welcome and thank you for joining the call today. Now turning to the results for the second quarter. Revenue came in just above the high end of the guidance at $99.1 million, representing an increase of 6% year-over-year and 2% compared to $97.1 million in the prior quarter. As Jamie mentioned, the supply chain continued to improve throughout the quarter, coupled with continued strong demand from our hyperscale customers. We had very strong bookings during the quarter which nearly doubled sequentially and contributed to a record backlog of $96.1 million as of September 30. The current quarter increase to a record backlog reflected the timing of several large purchase orders from hyperscale customers for future periods to ensure continuity of supply as opposed to being a result of supply chain constraints. We ended the quarter with approximately $25 million of shippable backlog and ended the second quarter with approximately $20 million which wasn't shipped during the quarter primarily due to lead times. Similar to prior quarters, approximately 85% of the backlog was with hyperscale customers. Although we anticipate supply chain constraints will remain, we do not expect this to significantly limit our ability to ship against customer demand. In the second quarter, secondary storage revenues were up 33% sequentially to 44% of revenue, primarily driven by ongoing strong demand from hyperscale customers and, to a lesser extent, an increase in enterprise, backup and data protection products. Primary storage systems declined 37% sequentially which reflects a combination of decreased shipments of our video surveillance solutions following our fulfillment of a large order last quarter, combined with soft media and entertainment and U.S. federal business. In terms of the supplemental metrics we use to track our ongoing transition to emphasize our recurring software subscription model, Annual Recurring Revenue, or ARR, increased 14% sequentially to $9.4 million. As a reminder, this figure includes recurring software subscription revenue across all of our transition product offerings, including StorNext, ActiveScale, DXI and CatDV. Additionally, at quarter end, the cumulative number of customers under a subscription contract increased to just over 550 active customers which represents a 180% year-over-year growth and sequential growth of 22%. In terms of total contract value, TCV, increased 9% sequentially to $17.5 million at the end of the second quarter, up $16 million in the prior quarter, up from $16 million in the prior quarter. Although we anticipated a slight sequential improvement in non-GAAP gross margin, we ended the quarter at 35% or flat with the prior quarter. While we have seen benefits from our previously implemented initiatives related to price increases, prudent management of discounting, reductions in PPV and other related supply chain costs, these were collectively offset during the quarter by approximately 2 percentage point gross margin decrease as a result of a less favorable product mix that was more heavily weighted towards our hyperscale customers. As I just mentioned, secondary storage was 44% of our revenue which compares to 34% last quarter due to the significant increase in the hyperscale business. Next quarter, we expect this strong growth in hyperscale revenue to continue offsetting the realized benefits from our cost initiatives and favorable pricing and therefore, expect gross margins to remain flat with the second quarter. Improving our revenue mix remains a critical focus area to help expand gross margin in order to drive improved operating performance and increased EBITDA. As Jamie mentioned, in order to improve the revenue mix, we are focused on building our enterprise IT business and have recruited top sales talent with years of experience selling into this market as well as recruiting new reseller partners focused in this space. Another key growth driver is selling our end-to-end portfolio into our existing customer base, effectively broadening our footprint within our existing customers and using this as a key leverage point. Also impacting GAAP gross margins during the quarter was an extraordinary inventory reserve provision of $6.9 million. There were 2 primary factors that contributed to the need for this inventory provision. First, due to longer purchasing lead times of up to 52 weeks during the pandemic and subsequent changes in customer requirements over this extended time frame, certain inventory had become obsolete due to next-generation products being released and the related legacy products being discontinued. In addition, following our integration of several past acquisitions, certain legacy products were discontinued and replaced with updated product offerings rendering the related inventory obsolete. We do not believe that the magnitude of this inventory charge is indicative of the company's performance and is not expected to be repeated in the near term. To meet the ongoing supply chain challenges, we have focused on supply chain excellence over the past year, including the following: first, establishing supply chain analytics to enable improved reaction time to supply chain disruptions, market demand changes and early technology transitions. And second, product management and supply chain are working closely together to reduce complexity, both in product SKU count and the supply base through supplier consolidation with the objective of being able to use components across multiple product lines. On the supply side, we will focus on supply partners for appliances that draw upon higher volume, more industry common platforms in which the supplier holds inventory until we need the appliance. We are also extending lead times on products that have lumpier demand and are more customized to the customer solution to reduce risk of holding inventory through technology transitions. GAAP operating expenses in the second quarter were $39 million compared to $41.1 million in the prior quarter. The non-GAAP expenses for the second quarter sequentially decreased $1.5 million to $34.8 million or just below our targeted run rate of $35 million. I want to further emphasize that $35 million was our target for the end of fiscal 2023. Therefore, we achieved this level effectively 2 quarters earlier than initially planned. The decrease in operating expenses were primarily due to lower head count levels and higher cost geographies. GAAP net loss in the second quarter was $11.9 million or a loss of $0.13 per share compared to a net loss of $10.6 million or a loss of $0.13 per share in the prior quarter. Excluding stock compensation, restructuring charges and nonrecurring charges, non-GAAP adjusted net loss in the second quarter was $0.5 million or $0.01 per share compared to adjusted net loss of $3.6 million or $0.04 per share in the prior quarter. Adjusted EBITDA for the second quarter was $4.1 million compared to $0.3 million in the prior quarter. Included in the second quarter adjusted EBITDA was $2.4 million of other income related primarily to a benefit from foreign currency exchange rates and the sale of certain intangible assets compared to $0.8 million of other income in the prior quarter, related primarily to a benefit from fluctuations in foreign currency exchange rates. As we have discussed previously, driving improvement in our adjusted EBITDA remains one of our highest priorities. With our lowered operating expense run rate and continued top line growth, as we outlined earlier, improving gross margin will be the key factor to fully realizing increased improvements in our quarterly EBITDA results. There's a full reconciliation of our non-GAAP results to the most directly comparable GAAP measure in both the press release and the Form 10-Q released today. Now turning to the balance sheet. Cash and cash equivalents at the end of the second quarter were $25.9 million compared to $26.8 million in the prior quarter. Outstanding term debt at the end of the second quarter decreased by $1.2 million to $77.2 million from $78.4 million at the end of the prior quarter. At the end of the second quarter, the outstanding balance on the company's revolving line of credit was $21.5 million compared to $17.3 million in the prior quarter. Interest expense in the second quarter was $2.7 million compared to $2.1 million in the prior quarter and $3.1 million during the same quarter a year ago. Our cash and cash equivalents decreased by $0.9 million during the quarter. Net cash provided by operating activities during the current quarter was $0.4 million and represents a significant improvement over the $18.3 million net cash used in operating activities in the prior quarter. The fiscal year-to-date net cash used in operating activities was $17.9 million. And this use of cash approximated the $17.7 million decline in deferred revenue that was primarily driven by seasonality. As we mentioned on the call last quarter, historically, the heaviest bookings for service contract renewals have been the December and March quarters with decreases in bookings in the June and September quarters. Net cash used in investment activities was $4.8 million which represents CapEx. The net cash provided by financing activities during the quarter was $3.4 million and primarily represented increased borrowings and the revolving line of credit of approximately $4.2 million, offset by $1.2 million used to pay down outstanding term debt. Now turning to our financial outlook. As previously outlined, our fiscal 2023 objectives remain to continue growing revenue while realizing identified cost reductions. Although the pressure on gross margins associated with revenue mix remains a near-term challenge, we believe we are positioned to realize improvements in the coming quarters as our sales teams' ramp and secure additional wins for our higher-margin products and solutions. For our third fiscal quarter, we expect revenue to be $103 million, plus or minus $3 million. Non-GAAP adjusted net loss is expected to be $1.5 million, plus or minus $1 million; adjusted net loss per share of $0.01, plus or minus $0.01 per share, using an anticipated basic share count of 91.3 million shares. We expect adjusted EBITDA in the third quarter to be approximately $3.5 million. With that, I'll turn the call back to Jamie for closing remarks. Jamie?

Thanks, Mike. As indicated by our comments today, the team remains highly focused on executing and driving increased profitability in our business. Our end-to-end data management solutions are resonating with customers and partners. And we are actively expanding our software and systems business along with driving future growth in the federal and enterprise markets to increase our margins and improve our overall revenue mix. We are well positioned with record backlog which enables greater visibility into the long-term orders of our large hyperscale customers. With our expectation for continued improvements in the supply chain, we are guiding revenue for the third quarter to be above $100 million at the midpoint which will be the first time since 2019. With that, let's open it up for questions. Operator?

[Operator Instructions] Our first question comes from the line of Craig Ellis with B. Riley Securities.

Congratulations on the significant surge in the backlog. I wanted to start there. So of the two components, the shippable component declined, it looks like by about 20% and it's around $20 million, while the future period is up about 3x. So Mike, what caused the mix of backlog to shift so much towards future and our customers just starting to do more order pipelining? And if so, why are they doing that now versus earlier when components might have been a bigger issue?

Yes. I guess, first to talk about the shippable backlog. We've seen that steadily declined over the last few quarters. It's gone from $32 million to $25 million now to $20 million. And when we look out to next quarter, we'd expect that to go down about $5 million more. So we're getting pretty close to just a normalized level as far as shippable backlog. And then really, the big increase is future orders. And what we believe that is -- what's driving that is our large hyperscalers just want to ensure continuity of supply. So they're just placing these big orders on us. It's in the future. It gives us great visibility and helps us plan. But it's not created because we've got a supply constraint like it had been in the past.

And Craig, there's one other interesting development is we've been serving our largest hyperscaler coming on 4 years. So we're starting to see them begin to not only make additional capacity buys but starting to replace and upgrade some of the equipment that's 4 years old. So now we're getting both new orders as well as refresh and upgrade orders for the massive installed base that's there. So our quarterly sell to them is going up because it's including both new capacity and upgrades and refreshes to the capacity that's now coming up on 4 years old and some of it is out of service.

Yes, a nice dynamic to have. So with that, well, one clarification. So Mike, for the backlog, how long do those orders extend out? Is that a 12-month backlog, a 24-month backlog? What's the duration of the orders in that extended backlog?

It's about 3 quarters.

Three quarters, okay. So that is something I want to tie in to the gross margin point that you made with gross margins in the third quarter being flattish. So if we got a backlog that's $97 million and with that being a 3-quarter backlog, how is it that mix will shift to allow gross margins to go up over the next 3 quarters? Or are we really looking at flattish gross margins over the next 3 quarters until we get through what is a very robust period of secondary demand where mix is really working against the blended gross margin average?

Craig, it's Jamie. The reason for the gross margin pressure is that as we increase our hyperscaler sales, every additional $1 million that we bring in dilutes gross margin because it's margin-dilutive business. So to offset that, we need to include a mix of North American enterprise sales and U.S. federal sales which are among our highest margin business. Now our sales there, if you look in primary have fallen off a bit. And some of that is a result of us moving our sales organization from single product sellers to portfolio sellers, right? Our strategy is to sell our customers a full end-to-end portfolio of unstructured data products. So we've been shifting our sales force to a, I would say, a more capable enterprise seller. But when you transition the sales team, the new team needs to get up to speed, get going. And we're transitioning that North America team and our U.S. Federal team. Now we've made the hires. We've brought them through training. And we expect them to come on. And as they begin to sell at a higher level than our previous teams did, we're going to restore that mix. So it's really about less of a market condition. It's more of a result of us making pretty significant changes in the makeup of our North American and U.S. federal sales org.

Okay, Jamie. So just to tie that in with some of the numbers from the investor presentation then. After a quarter or two, if primary kind of stays at these $10 million level, you'd expect it to get back to the mid-teens? And with that, you'd get some upward mix pressure on gross margins. Is that how we should look at it?

Yes. I think you're going to see primary storage increase. And I think you'll see secondary storage sales into the enterprise and into U.S. federal increase and that's how we're going to restore margins, right. We do about kind of in the mid-40s of margin to the U.S. enterprise. And we're in the 60s and in some cases, 70s when we're selling to certain government very specialized government programs. So you can imagine the impact of 70 points margin business when it is offsetting margins in the 18% to 20% of the hyperscale.

Yes, makes sense.

Just a few million dollars of that business really makes a big impact to the margin. So it's really about mix. And so our -- we feel really good about the strength of our cloud business. Now we're putting a lot of energy into our North America enterprise and our U.S. Federal business to get that mix where we need to get the margins climbing back up into the 40s and ultimately where we hope to get to is into the 50s.

Got it, okay. And then last one before I hop back in the queue. The subscription customers, again, I think for about the third consecutive quarter, up by about 100, so nice to see. But Mike, you indicated that your expectation for that ARR target was pushed out from the end of this year to early '24. And so it seems like that 100 or that 100-qurter-pacing or the value per deal or in aggregate, just isn't pacing as you'd expected. Can you talk about what it will take to accelerate the customer adds from 100? I know I've asked about that before. But it seems a very critical question for getting the business to that 60% gross margin target very long term.

Yes. Craig, what we feel good about is our new customers are moving to subscription. They're happy to do it. We're not getting a lot of pushback. But as you pointed out, we need more velocity. We needed to accelerate more. So we're looking at a series of programs. One is we have certain customers who've been buying for us for 10 years, 15 years. And they're pretty set in how they buy from us. And when we move them to subscription, it's just a very different sets of, pricing levels and they're used to. And so we're looking at different -- certain customer incentives, certain sales incentives, channel incentives to accelerate people moving the subscription with us. And we're going to be executing a series of programs to pick up the pace there. Because I think we feel good about those products. We feel good about that business model. What we need to address is the velocity of customers moving to the new business model.

Yes, those incentives make sense.

Our next question comes from the line of Ryan Meyers with Lake Street Capital Markets.

Just one for me. I was just wondering if you could highlight your operating expense reduction efforts. And if you feel like there's opportunity to reduce this even further. It sounds like you made some positive strides here during the quarter. Just kind of curious if you think there's opportunity to lower those even more.

Yes. Thanks, Ryan. Yes, as we reported, coming in at $35 million was the target that we had for the end of the year. So we're 2 quarters ahead there. And we still will continue to optimize, look at what we can do, where we can do it. If we can do things in lower-cost geographies, we'll take advantage of that, look to optimize our facility footprint further. So we would expect to keep at this level, if not do better, as we go forward. That's definitely our target.

Our next question comes from the line of George Iwanyc with Oppenheimer.

Jamie, maybe just expanding on the economy and what you're seeing there. I know you talked about the sales transitions with the new hires and all of that. But are you seeing any areas where macro headwinds are impacting the business?

Our business certainly isn't as large as others who are seeing headwinds. We're certainly not macroeconomists. But at the same time, I have to say, I am not seeing deals being significantly pushed out because of economic concerns. I'm not seeing delays. I'm not seeing projects canceled. And it may be the areas that we play in data protection which is -- I don't think that's an area where people will cut costs. I don't see people canceling media and entertainment. They're not canceling shows or the news or movies or television series. So in the areas that we play, critical video surveillance, I don't see police departments cutting their budgets on video surveillance. I don't see television stations canceling shows. I don't see people cutting corners on anti-ransomware or data protection. And so maybe it's the areas that we play, maybe it's that our products are value-oriented. But I am not -- and I've recently spent a lot of time with our sales team. I am not seeing delays, cancellations. And that's why you see us for now multiple quarters in a row, raising our revenue outlook because our issues have been supply based. And as that's coming down, we're just seeing more and more sales flow through.

All right. And just following on that supply challenges. Good to see the improvement. Are there areas where you're still seeing any decommits or areas where you're still a bit concerned? Or is the visibility definitely a lot clearer at this point?

It's a little hard to answer, right? Because we've had the rug pulled out from us multiple times. So today, we have good visibility. We are not seeing people asking the outrageous prices that were being asked. We're not seeing the need to do these very expensive expediting of shipment. We're not seeing the brokers out there charging massive fees. So that has come down now that can start again in a minute if somebody decommits. But so far, we're a month into this quarter. We're not seeing decommits. We're not seeing broker fees. We're not seeing expediting fees. And we're receiving materials as expected. The only thing that I would say we see a bit of is some products have slightly longer lead times. Products we used to see in 2 to 4 weeks are now 4 to 8 weeks. And that's why we're kind of moving to more of a more natural shippable backlog of $10 million or $12 million when we used to be down to $2 million or $3 million because products where we get orders in the last 2 or 3 weeks of the quarter, we're not going to pay expediting fees to get that. We'd just rather roll that into the next quarter and get better linearity and better predictability in our business.

All right. And just my last question. You highlighted the AWS marketplace availability of StorNext and the extended partnership. How is the ecosystem evolving? Where are you focused on adding new partners? And how long do you kind of expect that effort to last before you start seeing some new customer gains from that?

Yes. The way I would characterize our partner ecosystem is Quantum 4 years ago was a niche vendor. We sold the media and entertainment. And we sold in new certain backup used cases. Today, we're an end-to-end provider. We provide a full suite of offerings during every life cycle stage for unstructured data. So now we're working with different partners. We're way more relevant to the enterprise than we used to be. So our largest effort globally in all our theaters which are North America, Asia Pac and EMEA, we are recruiting new channel partners that are more enterprise-oriented, that are more, broad in their scope than the niche partners that we worked with historically. And we think that is where we're going to see the most margin expansion. And I think that's where we're going to see the most revenue expansion is being much more relevant with more products to the general enterprise.

[Operator Instructions] Our next question comes from the line of David Duley with Steelhead Securities.

Yes. Congratulations on the nice results sequentially. A couple of questions from me. As far as your hyperscale business, you're kind of seeing a little bit of a slowdown in the growth rates of North American customers and I think some slowdowns internationally as well. How should we translate that into the growth rate of your business into this area? And I guess maybe if you could look into next calendar year or just help us maybe understand what the growth will actually be this calendar year?

Yes. I mean I can speak to why this occurred. We're not seeing a slowdown in the economy, anything like that. We're transitioning a sales force that's been here for many years as single product sellers into portfolio sellers. And that slowdown in some of these areas is a natural thing that we just have to go through when you move a legacy sales team into a next-generation sales team. We've had to cycle over some of our people and there's a learning curve. So that -- I think that's just a natural piece that we're going through. Mike, you can speak to growth rates. But I don't believe we've provided any forward guidance on growth rates beyond the quarter we're guiding to.

But to that point, Dave, we are having our Analyst Day on November 17. So we'll be looking out 5 years and we'll go year by year. So we definitely can give a lot more color as we go through that presentation.

Yes. No, for calendar 2022, you just gave guidance for the December quarter and I don't have the numbers in front of me. What do you think the hyperscale business did in calendar 2022 or will do if you hit your guidance?

For the current quarter? For the current quarter, the hyperscaler continues to grow.

If you just assume that you hit your numbers in the current quarter for hyperscalers, what will the growth rate be for calendar 2022?

We never -- we don't break out individual groups like that. I mean you can look at the secondary and understand that the hyperscalers are the biggest group included in that business unit and that.

How much did the secondary grow and that's been growing significantly.

Yes. I mean it grew 33%, well the hyperscalers grew 33%, the secondary grew.

Okay. And as far as the hybrid -- business is this mainly a North American business? Or is there any risk from international restrictions in China and whatnot?

Yes, it's an international business. We have Chinese hyperscalers, U.S. hyperscalers. We have Telcos that are trying to be hyperscalers. So it's an international business. Cape which is predominantly what we sale is a product that the Chinese government has said they will not be trying to make. Similarly, India is saying that is a product they're not trying to make themselves. So they are -- they have made a decision to import that from the West.

Okay. And then finally for me, you touched upon it a little bit. But you've talked about how your federal business is weak and your media and entertainment business was weaker in your U.S. non-hyperscale enterprise businesses. What would be the timing or your best guess as to see when those segments start to improve sequentially or year-over-year? Or how are you look at them?

Right now, I mean that's why we're guiding to a $103 million is -- and we'll continue. We think we'll continue to guide up as -- think of it as we've hired over 15 new sales reps. So last quarter with the $99 million, there were 15 sales reps, who contributed nothing. Now they're brand new. There new hires are coming up to speed. When they come on, where we quoted people at over $3 million a year, you can imagine as they come on, how that's going to contribute. So we're feeling pretty good about the hires we've made, about the boot camps and the training we've done. They're going into territories that are not cold. They were cultivated prior to them. There's large installed bases in those territories. So that's part of the reason you're seeing us not only have beaten our range and been above our range but guiding up as well.

And our next question comes from the line of John Fichthorn with Dialectic Capital.

Yes. Guys, nice work in the backlog and hitting the numbers. I guess everybody is trying to kind of get to the same answer here. And so I'll ask the same question in a different way which is you're guiding to $103 million, it's great. And Dave just asked about kind of the mix here with hyperscalers or tape. And so you're forecasting growth but you're forecasting flat gross margins which would imply that all of the growth is coming from hyperscalers and yet you're also talking about these 15 new sales guys which I'm excited about, gaining traction in things like primary storage and federal and media and entertainment and that somehow should imply higher gross margins. So I can't quite square that circle.

Yes. So you're absolutely right in that we have been growing our hyperscaler business while having some historic declines in our most profitable, highest margin businesses. So to break the margins go up, we need to sell more in North America and sell more in U.S. Federal and also another driver is increased service sales which is a little more challenging in the short term. So we knew about this over a year ago. We've made -- we done the recruiting. We've done the hiring. We've done the training and the people are now -- I was just at a boot camp, where we trained a large group of these new folks and we expect them to start to contribute. We don't know the speed at which they're going to come online. We don't know exactly how to forecast that yet. And so we're guiding to strong EBITDA. The other thing, though, if you look at that $96 million in backlog, what does it tell you? If it's mostly hyperscaler, that means not only is hyperscaler sales gone up this quarter, they're probably going to go up in the quarters in front of us. So that means an additional headwind that we have to sell into to offset the dilution of increasing hyperscaler sales. And we haven't fully characterized that yet. And that's why EBITDA of $3.5 million is strong. But it also has some conservatism in it and that we just don't know exactly how effective in the timing of these new reps coming on board is. I've met with them all personally. I can tell you this is a much more experienced, much more mature enterprise selling org than we've had in the past. I'm really optimistic about them. But I cannot draw a line through their performance yet because it's just too new.

So like in the case of federal, just to focus on a specific vertical, typically, it's -- this was that quarter. Is that something where you still think your new sales rep is going to be able to drive growth in federal maybe year-over-year but it's maybe sequentially because it didn't seem like it was that great quarter for Federal, this quarter?

Yes, it's interesting. If you look at Dell, Cisco, us, a lot of us got deals pushed by U.S. Federal and they're continuing the budget. What's interesting is it's usually use it or lose it money in the government sweeps quarter which ends September 30. But with the continuing resolution, they're carrying money from last year forward. So I'm feeling pretty good about our U.S. Federal business. I'm feeling really good about the programs that we're part of and that there's going to be pretty big refresh budgets there. So I'm pretty optimistic about U.S. Fed. And I think we've had -- we have stronger leadership in that segment than I think we've ever had and some of the strongest new hires we've made are in that segment. And I'm pretty optimistic about how that group is going to perform. And I'm feeling pretty good about how the U.S. government with sweeps, did not do use it or lose it money. Any monies they allocated last year, they kept almost all those monies that where they couldn't get deals done, they kept the monies allocated into the new year.

Got you. And so one other interesting area you've now had for a little over a year is in your SaaS business, you're almost $10 million in ARR. Can you give me a little color on, A, what does that represent, would that have been something far greater in revenue, had it been kind of traditional revenue that you booked or not? And what is the margin profile of that business as we look to see how you get to $50 million?

Yes. I mean, I'll let Mike provide some of the details. But most importantly, in the old model, we would not have captured as much revenue or margin. In the old model, when people bought appliances, where the software was bundled into it, they undervalued our software. They often wanted it almost for free and they didn't pay us for capacity. So in the new model, we get fully paid for our software. We get paid for additional features in the software and we're paid for capacity. So we had revenue leakage in the old model and we plugged those leaks. So definitely, the new ARR model is better for Quantum, both from total revenues captured over lifetime as well as the margin. So I'm very glad we made the transition. I like seeing the -- I also think we posted pretty strong TCV numbers in addition to ARR. So I like how that's building. In the traditional model, we would have gotten more cash up front and some people might say that they like that model. But the majority of our customers are paying us 3 years upfront. So we're not even seeing that much delay in cash either in that. We're providing incentives for customers to buy on a monthly subscription but pay 36 months in advance. And the majority of our customers are opting for the 36 months in advance to get some of the incentives and discounts for paying upfront.

Got you. Two more, I'll try and keep them quick. You said 85% of backlog was hyperscaler. Does that mean 15% is not even tape-oriented and it's in other products? Or is it just not a hyperscaler but it's still on tape?

No. I mean a good example is some of our customers in our video surveillance business need boxes with a lot of GPUs in them to do facial recognition or license plate recognition or advanced analytics. Those boxes are about an 8-week lead time. Some of them are 12-week lead times. So basically, what you sell in this quarter, you ship next quarter. So we do have servers on those kinds of delays. The F-Series, as you know, has very expensive NVMe in it. And some of that NVMe is long lead time products as well. So there's F-Series products, surveillance product and certain DXI product is in those longer lead time products that will push out of the quarter. So it's not all take.

Got you. My last one, so roughly, you're doing $100 million in revenue, you've got 35% gross margin which is $35 million. You've got $35 million in OpEx. It seems like this is kind of breakeven. Do we feel confident because it's pretty lumpy, right? You've got some quarters, you've got 44% tape and you're hoping these other ones grow. But are you feeling pretty confident that this is kind of the base case for your business model and we're going to see sequential growth from here? Is there still going to be a lot of seasonality? I mean, even though you're guiding to $3.5 million in EBITDA, you did generate a little cash this quarter. We'd love to see that. I'd love to hear your thoughts on cash flow. There was some working capital that reversed which was great. But like from here, is it top line growth? Is it top line growth and gross margin growth? Is it more gross margin growth than top line growth? What do you see as you think?

I get where you're going. I mean, I'll tell you exactly kind of how we're running the business. One is, we feel pretty comfortable with the backlog with what we see. We are running at $100 million plus per quarter now consistently. We think that can be -- with the new sales team coming online that can get to $110 million, $115 million. That's where we're trying to get to. In addition, we've got to get our margins back up to 40 points plus. We're going to do that with the reps that are operating in the highest margin areas and we're grinding costs more. We've identified up to another $2 million per quarter of cost we can take out, some on a run rate, some on a onetime. But obviously, my goal is to drive top line, drive margin, drive additional cost cutting. So I get to at least $6 million in EBITDA, where I know conservatively, that's throwing off at least $1 million of free cash flow. And that's what I'm trying to get to is now we're in -- I mean, it was just a few quarters ago, we were at $300,000 in EBITDA. Now we're at $4 million. I got to push that to around $6 million. So we moved from positive EBITDA to free cash flow. And that's where I think we all get a lot more comfortable as we start to build our balance -- build the balance sheet with cash going into the bank. And that's how I think about the business right now. So my goal is be we've got a pretty good model now where we've been beating guidance and my goal is to beat guidance this quarter and beat it enough to throw off cash.

That's a clear business model answer as I've ever gotten on a conference call. So I really appreciate it.

And our final question comes from the line of Nehal Chokshi with Northland Capital Markets.

Yes. My congrats on the strong bottom line. There's a lot of discussion here on the new quota sales reps here. Just to level set, how many total quota carrying sales reps you have now?

Well, we have outside and inside quota-carrying reps but rough and tough, I'd say it's about between 50 and 55 quota-carrying people.

Okay. And prior to the restructuring, where were you at?

We're about 50 to 55 what they were point product sellers. So people who just sold DXI, people who just sold StorNext for media and entertainment. The new salespeople are people who sell full portfolios. They come from organizations like Cisco, where there's 2,500 products or Dell where there's 2,000-plus products. So it's -- these are salespeople that may be a little more tenured, a little more experienced. They cost a little more. But they carry much higher quotas and they do more targeted account selling than what we did previously was just sell anything you can to anyone who's in front of you. Our new reps are moving to more named accounts where they just work 20 to 25 accounts but do a lot more inside those accounts.

Okay. And just to be clear then, prior to the restructuring, each quota-carrying sales rep was effectively a point product salesperson. And you converted most of them to a multiproduct salesperson. Those that weren't converted were let go and you hired a new 15?

I mean the number is about 15 in North America. But I think of it as some of our salespeople made the transition from being maybe focused on a certain area to being more generalists. I think everyone knows that there's been a lot of turnover in all U.S. businesses. So we've had a certain amount of turnover ourselves. We've had certain people that just weren't successful here. So we had a series of reasons of why we've cycled people over. But in that process, we've moved to end-to-end sellers versus point product sellers. A lot of them are new. And right now, it's a race to get them up to speed, get them up to quota. And we're investing in training boot camps, all the things we could do to get them up to quota as fast as we can. And we think that will rebalance the mix. And by rebalancing the mix, the margins should go up. But I think 35%, we're expecting 35% to be the low point. And we just got to bring it up from here.

Yes, absolutely. Okay. And just to be clear, you believe you're not seeing any negative macro signs at this point in time?

I'm not but we're a small business. We operate in a few niches. So I don't have the view that a massive company -- like a Dell or Cisco or HP have. But in my little view and I have recently traveled to Asia, Europe and across the U.S. to Atlanta to New York to L.A. to Seattle. And in all my travels and I visited over 30 customers face-to-face, I have not had a discussion of, hey, we got to slow down or hit the Br-exit. But my purview is probably smaller than CEOs of bulge bracket companies.

Yes, understood. And then finally, can you just -- and I might have missed this. But I'd love to hear an update on the PIVOT 3 acquisition, the performance of that asset.

Yes. I mean those guys are doing phenomenal. They just won another huge Department of Homeland Security award. They are -- they're doing really well. I think they got some long lead time products because what's happening with video surveillance is most VMSs now need a lot of GPUs to analyze the video and just making those products longer lead time. And we're not going to pre-buy systems. It's just too much inventory risk. But I like where that business is going. The other thing is a lot -- we just did across Asia, Europe and 3 different meetings with partners in the U.S. We do an annual Elevate Conference. So we brought in over 100 partners in Asia, 150 partners in Europe and probably close to 200 partners in New York, L.A. and D.C. And the product that I found everyone was most excited about adding to their portfolio was video surveillance, particularly in Asia. We had to go back and do a whole another series of meetings about surveillance. So it's generating a lot of excitement in the partner base. So I think that's a good buy for us. I think we've got a lot of innovation there. The USP has now shift the unified surveillance platform which is the integration of PIVOT 3 with the cloud in assets, where the software runs on any server, any hypervisor can run on the cloud, virtualize. So, it's -- I think the technical architecture is in a leadership position. And it really is the platform of choice if you cannot lose any frames of video. So if you're a police department, homeland security, defense department, run a casino, a bank or you just cannot run any risk of losing that video. The PIVOT-3 platform is the leading platform for those used cases.

And we have reached the end of the question-and-answer session. I'll now turn the call back over to Jamie Lerner for closing remarks.

All right. Well, thanks, everyone. It feels great to be back beating guidance and raising our revenue. And I think that trend is one we plan to continue, yet being conservative and recognizing the fact that there are still supply chain disruptions. There's still a lot of uncertainty. But our products are value-oriented. We think they do well when customers have to spend wisely and we like how our products are positioned for this market. And we look forward to speaking to you all on November 17, where we'll be having our Annual Investor Day. And we'll be updating our 5-year model with what we've learned over the last year. So I look forward to seeing you all then. Until then, thanks so much and we'll talk soon.